Wednesday, December 17, 2014

Fund Managers' Current Asset Allocation - December

Every month, we review the latest BAML survey of global fund managers. Among the various ways of measuring investor sentiment, this is one of the better ones as the results reflect how managers are allocated in various asset classes. These managers oversee a combined $700b in assets.

The data should be viewed mostly from a contrarian perspective; that is, when equities fall in price, allocations to cash go higher and allocations to equities go lower as investors become bearish, setting up a buy signal. When prices rise, the opposite occurs, setting up a sell signal.

Here's a brief recap of the past several months:

July: fund manager equity allocations reached a bullish extreme. At +61% overweight, it was the second highest since the survey began in 2001, a clear risk to near-term equity performance (post).

August: the Euro 350 dropped 8% and SPX dropped 5%. In response, equity allocations fell and cash shot up to 5.1%, a high level associated with lows in equities (post).

September: equities in the US hit new highs; Europe rallied, but fell short of new highs. Fund managers raised their global equity exposure and reduced their cash (post).

October: equities worldwide fell more than 7-10%; most markets were, at least briefly, negative for 2014.  Bond yields made new lows. Fund managers raised their cash levels back to 4.9%. Equity allocations dropped to their lowest levels in 2 years (post).

November: new uptrend highs in the US, Japan and Germany; cash levels fell and equity allocations rose to near their prior highs.

Since then, equities have again fallen. So it's not a surprise to see that in December, cash is now up at 5% again. This is a strong positive. But, strangely, equity allocations are also up to a 5 month high. To say that there are mixed signals is an understatement.

Let's review the highlights from December.

Fund managers increased their cash levels to 5%. Instances are very low, but over 5% represents bearish sentiment: this is where bottoms in equities have formed in the past.  The last three times cash was over 5% was in June 2012, May 2014 and August 2014. Each time, SPX rose in the month ahead.

Strangely, global equity exposure also rose. Fund managers are now +52% overweight, an 18 percentage point increase since October. The only other time equity allocations have been this great in the past year was in July; equities fell later that month. We consider current levels to be bearish.

As we have continually noted, what has been remarkable is how long managers have been highly overweight equities (virtually since the start of 2013). This is longer than any period during the 2003-07 bull market (yellow shading). In the past, after overexposure like that seen in the past 2 years, a washout low would be marked by an equity weighting under +15-20% (green shading).

Last month, US exposure jumped to a 15 month high of +25% overweight. What is surprising is it fell in December to +16%, even though the US market has been outperforming the rest of the world. Over +20% has been over-owned in the past (green shading); it is currently neutral.

Until July, Europe had been the consensus long for 11 months in a row. Since then, the region has strongly underperformed and allocations fell as a result. Strangely, given its poor performance, allocations in December increased threefold, from +8% overweight to +26%. It's no longer a dark horse expected to outperform.

Managers have their largest equity exposure in Japan. Allocations the past two months haven't been this high since April 2006. It looks extreme. Managers expect both Europe and Japan to benefit from central bank liquidity.

Managers were -31% underweight EEM in March. This was a strong contrarian buy. In the ensuing months, the region strongly outperformed. In August, allocations increased to +17% overweight, the highest in 17 months. As we noted then, the fat pitch had passed. Exposure is now back to neutral. This is where bottoms form, but, in the past, it has taken more than one month for a solid low to be put in.

Remarkably, although US bonds have outperformed SPX so far in 2014, fund managers are -59% underweight. Bonds continue to be the most hated asset class and this, in large part, explains why cash balances have not been lower that 4.5% in the past year. For comparison, managers were -38% underweight in May 2013 before the large fall in bond prices. There is a lot of room for bond exposure to rise.

Fund managers are -26% underweight commodities, a new 12-month low. Managers view oil as more overvalued than at any time since early 2009. This corresponded with the low in oil, from which prices rose threefold over the following two years.

Globally, managers are not just overweight equity and underweight bonds, they are overweight the highest beta equity (technology, discretionary, banks) and underweight defensives (telecom, staples). The largest underweight is energy.

That is equally true in the US. Tech is the most favored sector, followed by pharma and banks. This has been the case for many months. Utilities, staples, telecoms (defensives) and energy remain very underweighted. 

In 2014, utilities and staples, two of the least liked sectors, have strongly outperformed, along with health care (all defensives). Among cyclicals, only tech and financials have outperformed. Energy has been the obvious loser. 

You can see from the data that it should mostly be looked at from a contrarian perspective. Fund managers were overweight EEM more than any other market at the start of 2013, and it was the worst performer that year. In comparison, they were 20% underweight Japan in December 2012 and it was the best equity market in 2013.  

Survey details are below.
  1. Cash (+5.0%): Cash balances rose to 5.0% from 4.7% in November. Typical range is 3.5-5%. BAML has a 4.5% contrarian buy level but we consider over 5% to be a better signal. More on this indicator here
  2. Equities (+52%): A net +52% are overweight global equities, up from +46% in November.  In July it was +61%, the second highest since the survey began in 2001. Over +50% is bearish. A washout low (bullish) would be under +15-20%. More on this indicator here
  3. Bonds (-59%): A net -59% are now underweight bonds, a steep fall from -52% in November. For comparison, they were -38% underweight in May 2013 before the large fall in bond prices. 
  4. Regions
    1. US (+16%): The November weighting was a 15 month high (+25%), but that fell to +16% in December. They had been +30% overweight in August 2013 (the third highest US weighting ever). 
    2. Europe (+26%): Exposure to Europe jumped from +8% to +26% overweight in the last month. Before August 2014, Europe had been investors' most most preferred region for 11 months in a row. 
    3. Japan (+40%): Managers are +40% overweight Japan, down from +46% in November which was highest since April 2006. Funds were -20% underweight in December 2012 when the Japanese rally began. 
    4. EEM (+1%): Managers increased their EEM exposure to +1% overweight from-5% underweight in October. 
  5. Commodities (-26%): Managers commodity exposure fell to -26% underweight, the lowest in one year. With the exception of August, it has been less than -15% since early 2013. Low commodity exposure goes in hand with low sentiment towards EEM.
  6. Macro: 60% expect a stronger global economy over the next 12 months, an increase from 32% in October. January was 75%, the highest reading in 3 years. This compares to a net -20% in mid-2012, at the start of the current rally. 

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